Divorce and Taxes – Part I: Filing Status and Dependents
When you said “I do” you may not have given much thought to what you were doing. Legally, that is. The reality is that all you really did was change your tax filing status from Single to Married. Pretty simple, right?
It doesn’t become complicated until you decide to divorce. The financial untangling can be tricky and there are important tax implications to consider.
Tax Filing Status
Marital status for any given tax year is dependent on whether your divorce was finalized on or before December 31st.
Even if married most of the year, there is no option to file married filing joint or married filing separate if you were divorced as of December 31st.
For those, however, in the middle of a divorce with a child/ren, there is another status to be aware of called head of household. To qualify, you must have lived apart from your spouse for the last six months of the year, paid over half the cost of keeping up your main residence, and be able to claim a child as a dependent. This also requires that you file separately from your spouse, so it may not be the best tax strategy overall.
The Dependency Question: Who Will Claim the Child/ren?
The 2014 Dependent Exemption is $3,950 with a phase-out beginning at $254,200 for single filers, making it a tax issue worth talking about.
Generally, the custodial parent is entitled to the dependency exemption. However, the IRS allows parents their choice of who will claim the exemption, providing flexibility that can be used to create a “fair” situation. Some parents may choose to alternate years, parents with two or more children may decide to “split” the deduction with each taking one child, and others may determine the most advantageous tax result based on income for each party and assign the exemption accordingly. For example, it might make sense to have the higher wage earner claim the dependent exemption, even if they are not the custodial parent. Or, if there is a low-income parent, they may be better off claiming the exemption as well as earned income credits if under the income cap, which starts at $38,511 with one qualifying child in 2014.
The custodial parent must sign IRS release Form 8332 each year if he or she will not claim the child as a dependent. The non-custodial parent claiming the exemption must attach the form to his or her return. When the custodial parent will not claim the child as a dependent for several years, a similar statement can be made and signed indicating details and the years it is in effect rather than having a form signed and exchanged every year. Whether one year at a time or several, it may be convenient to have the form(s) or statement completed and signed at the time of the divorce.
There is also a Child Tax Credit of $1,000 in 2014 that goes to the parent claiming the exemption, but it is reduced by $50 for every $1,000 earned over $75,000 for single filers. An Additional Child Tax Credit may also be available, but qualification is a bit more complicated.